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Sales - down. Margins - down. Losses - up.

Quote: Overstock.com, Inc. (NASDAQ: OSTK; www.overstock.com) today reported financial results for its third quarter ended September 30, 2006.

·      Q3 Total revenue: $158.7 million, down 6% versus 2005

·      Q3 Gross profits: $22.9 million, down 14% versus 2005

·      Q3 Gross margins: 14.5% compared to 15.7% in 2005

·      Q3 Net loss: $(24.5) million or $(1.19) loss per share compared to $(12.4) million or $(0.66) loss per share in 2005

Dear Owners,

The Q3 financial results were poor. For the first time in our history, quarterly revenue decreased compared to the prior year. In addition, early fourth quarter revenue continues to lag slightly behind last year’s revenue.

This year we have been fixing business processes and systems integral to serving our customers. Most of these projects were completed ahead of schedule and, as a result, customer satisfaction rebounded beautifully— based on our Net Promoter Score we have surpassed our previous levels of customer satisfaction (as we just announced, a recent national poll ranked us #4 in customer service in the nation). In Q3 we were confident enough to begin ramping up offline advertising. However, conversion — the percentage of visitors who became buyers — was weak, too weak, in fact, to overcome with marketing. As a result, our marketing efficiency suffered, though we have finally achieved our long sought goals in consumer awareness of our brand.

I will provide a brief update on operations, a more lengthy discussion on what we’re doing to improve marketing efficiency and site conversion for the holiday season and beyond, then briefly discuss the balance sheet and two litigation matters. I’ll end with some thoughts on what I think the future may look like.

Quote:OPERATIONS UPDATE

Operationally, things are snapping into place: I believe that we have never been better prepared for the holidays. Customer satisfaction scores have rebounded to levels at or above where they were before our IT problems last fall. This is a reflection of improvements made in Customer Care, IT, Logistics and Merchandising this year.

IT Systems: After years of frenetic growth on a shoestring, we have a smoothly-running technology platform upon which to grow the business (just as growth has died).

Logistics: Stress tests show our order management system can process over 10x the order volume it could last year. Efficiency at our Salt Lake City warehouse has improved by more than 100%, bringing about a handsome decline in variable costs.

Merchandising: Currently we are supporting approximately the same level of sales as last year with only slightly over half the inventory we had at the same point last year. This is the result of a tremendous amount of work that has gone into reducing complexity within Merchandising, especially by eliminating poor performing products. I expect one further stair step in inventory efficiency, along with a stair-step in gross margins (though gross margins will suffer in Q4 as we chop out this inventory).

Customer Care: In Q3 we completed Phase 1 of the implementation of RightNow Technologies. It may be the best managed implementation we have ever done. Phase 2 —Voice Self-Service — should go live this week, which will make it easy for customers to handle some functions (such as order tracking) on their own without speaking to Customer Care. That said, customers will still be able to reach live associates at any time.

MARKETING UPDATE

Marketing: We intended to keep our marketing spend around 7% of sales this year. However, having entered Q3 with our systems and processes on solid ground, we increased marketing to get ahead of Q4. Unfortunately, sales did not follow.

Online we’re fighting inflation from increases in costs-per-click and the expiration of portal deals, which are either no longer available or else too expensive now to justify. We can overcome this by becoming better in our keyword buys. Marketing is now more granular in its analyses through our internally-developed search engine marketing tool, which we expect will let them manage keyword buys better.

We also increased offline marketing, mostly in radio. According to the survey we commissioned in September, our prompted name recognition is 65% among consumers and 81% among Web shoppers, making Overstock.com a remarkably powerful brand with the same level of brand awareness as Amazon. Yet so far we saw little sales traction

Quote:rom this spend. For that reason, we are now directing the majority of our marketing dollars to projects that we expect will directly improve conversion.

Internal Marketing (Web Site and Email): We are rebuilding this function piece by piece. We’ve outsourced some of these functions to firms who have proven capable of implementing their technologies relatively quickly for a reasonable cost.

Collaborative filtering (e.g., “People who bought this also bought that”) is now done by Aggregate Knowledge on all our product pages. It will be extended further throughout the site this month.

Bayesian recommendations (e.g., “This kind of customer should be shown these products”) will be provided by ChoiceStream. They personalize parts of the Yahoo! site and other large media sites. The only part we will have live in 2006 is a gift finder: tell us for whom you are shopping, your relationship, answer some questions about the recipient, and we generate a page of gift recommendations. We plan to extend this technology across the Web site and to email marketing in the first half of 2007.

Content management will be provided by Kefta by November 17. More details on this in the future.

BALANCE SHEET

Inventory: We’ve become much more efficient at managing inventory, and we may get even better. I expect to end 2006 with an inventory balance under $50 million.

Cash: We experience our annual cash nadir in early November, and then see a steady inflow of cash through the remainder of Q4. Come January a significant fraction of that cash will drop from our balance sheet as we pay partners. Depending on how the next few quarters play out, we may or may not have a need to raise cash in 2007. Note that our inventory line of credit remains available to us should we need it (currently an additional $32 million is available to us under this line).

LITIGATION

Two updates on litigation:

Furnace Brook: Since August 2005, we’ve been in litigation with a patent troll (the characterization is that of the United States District Court of Utah) who alleged our business practices and Web site infringed its patent. On October 30, 2006, the United States District Court for the Southern District of New York granted summary judgment in our favor, ruling that we do not infringe the patent as a matter of law. The court’s

Quote:decision ends all claims against us by Furnace Brook, barring an appeal which we will defend as vigorously as we did the original case.

Rocker/Gradient: Our suit against Gradient Analytics, Rocker Partners, and their principals remains on appeal with the California Court of Appeals. All parties have submitted briefs. The California Attorney General also submitted an amicus brief supporting our view of the law. The court has informed the parties that it is ready to rule on the appeal without hearing oral argument; we agreed to this but the defendants have requested oral argument. The defendants seem intent on doing all they can to delay what I view as the inevitable discovery process. We will pursue this action aggressively.

WHAT DOES THE FUTURE LOOK LIKE?

I have been unsuccessful at predicting the future for a while, but here are my thoughts on the subject.

The IT problem that developed last September, which we have discussed at length in prior communications, has had lingering effects that ran well into this year. In fact, while we viewed it internally as a 2005 Q4 — early 2006 Q1 problem (which is what it was technologically), I see now that in terms of affecting customer behavior it was more of a 2005 December — 2006 April problem. It has taken an enormous amount of work to recover, but our operations and infrastructure are now healthy and strong. In the past we ran at an A- and regularly generated 100% growth: now I think we are running at an A+ but seeing no growth. I am not entirely sure what to make of that. I anticipate (at least in the sense of, “am prepared for”) a slow, steady updraft in growth as we get into the holiday season (but mention that this could be offset by other factors, and repeat that, as noted above, we’ve not yet seen a lift in early Q4 results).

There are a few things that may break in our favor, but I am not counting on any.

·                  Our name recognition is fantastic. Analysis shows that as we built more and more name recognition in prior years it created a bigger and bigger holiday spike (until our problems last year broke that trend).

·                  Our NPS (Net Promoter Score) is superb. Our customers are extremely satisfied.

·                  Some of our new technologies mentioned above may ratchet conversion up a click or two.

·                  We have a couple inexpensive skunkwork projects that may work out quickly.

Quote:Who knows: taken together, these factors may (or may not) give us a boost during the holidays. Or they could be offset by unforeseen factors. One point about which I am confident: our IT and Logistics systems and operations are well prepared for whatever wave washes over us during the next six weeks.

I look forward to discussing these developments on our call.




Humbly submitted,




Patrick M. Byrne



P.S. If you have questions, please feel free to email them to Kevin Moon at kmoon@overstock.com before the conference call, so we may address them.

KEY FINANCIAL AND OPERATING METRICS

Total revenue—Overstock.com reported total revenue for the three months ended September 30, 2006 of $158.7 million, a 6% decrease from the $169.3 million reported in 2005. For the nine months ended September 30, 2006, total revenue increased 3% to $498.9 million from $485.8 million in 2005.



Gross profit and gross margins—Gross profit for the three months ended September 30, 2006 was $22.9 million (14.5% margins), a 14% decrease from the $26.6 million (15.7% margins) reported in 2005. For the nine months ended September 30, 2006, gross profits totaled $71.1 million (14.3% margins), a 4% decrease from the $74.0 million (15.2% margins) in 2005.



Net loss—Net loss for the three months ended September 30, 2006 was $24.5 million or $1.19 loss per share, compared to $12.4 million, or $0.66 loss per share, in 2005. Net loss for the nine months ended September 30, 2006 was $56.2 million, or $2.81 loss per share, compared to $18.6 million, or $0.96 loss per share, in 2005.



Overstock.com had cash and marketable securities of $39.4 million and working capital of $56.6 million on September 30, 2006.

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The complete filing is available here: http://investors.overstock.com/phoenix.zhtml?c=131091&p=IROL-secToc&TOC=aHR0cDovL2NjYm4uMTBrd2l6YXJkLmNvbS94bWwvY29udGVudHMueG1sP2lwYWdlPTQ0NjcxODUmcmVwbz10ZW5r

The company is going to pot because Patrick spends all his time pursuing his crusade against short sellers. :asshat2: